PEP GUARDIOLA may have to take a backward step before guiding Manchester City to football's top table.

The three-time Champions League winner - once as a player, twice as a manager - could find himself saddled with the embarrassment of managing a team in the Europa League for the first time next season.

Such is City's dire form, the nightmare scenario now looming for them is failure to qualify for the Champions League - unless, of course, they recover from their domestic troubles, overcome Paris Saint-Germain and go on to win Europe's prestige club competition.

City's decline was unthinkable at the start of the season, when they won their first five games without conceding a goal, and still unthinkable when they officially confirmed football's worst-kept secret on February 1 that Guardiola would replace current boss Manuel Pellegrini this summer.

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But since then City have taken only four points from their last 18 in the League, although they did raise their game to get past Dynamo Kiev to reach the Champions League last eight and win the Capital One Cup after a penalty shoot-out with Liverpool.

Guardiola didn't need to watch Sunday's derby defeat to know that City's squad needs big changes this summer. He is understood to have been studying their games on television and DVDs and along with sporting director Txiki Begiristain has already worked out this summer's transfer strategy.

Senior City sources suggest there will be a significant squad rebuild in an attempt to recapture the Premier League and win the Champions League for the first time - if they are in it.

City have already opened talks with Borussia Dortmund's Germany midfielder Ilkay Gundogan. Also believed to be on their hit list is Athletic Bilbao defender Aymeric Laporte, Everton defender John Stones, Bayern Munich striker Robert Lewandowski and his team-mate, left-back David Alaba.

Since Guardiola's appointment was announced, City are understood to have been inundated with calls from the agents of players in England, Spain, Italy and Germany, desperate for their clients to play for the Spaniard who is considered the best coach in world football.

Guardiola's clear-out will start with out-of-contract defender Martin Demichelis, and the Argentina international will just hope his nightmare in the Manchester derby on Sunday wasn't his last appearance in a City shirt.

Fellow centre-back Eliaquim Mangala has also not justified his £42m transfer fee and is likely to be moved on.

Bacary Sagna, Pablo Zabaleta, Jesus Navas and Wilfried Bony are all under scrutiny while even stalwarts Yaya Toure and David Silva look to be on the wane.

For so long, they have been City's match-changers, along with Sergio Aguero, but they made no significant impact in Sunday's derby when the hapless Demichelis took the brunt of the blame.

City have not been moved by the demands of Toure's outspoken agent Dimitri Seluk to hand his client a new three-year contract. He has a year left on his current deal and with his 33rd birthday looming in May, City have no plans to extend his stay beyond that.

But it is understood there is no personal issue between him and Guardiola, despite the former Barca boss having sold the midfielder to City in 2010. Those close to Guardiola say it was simply because he was behind Xavi, Andres Inesta and Sergio Busquets in the midfield pecking order at the time.

Despite his injury problems, Vincent Kompany will not be shown the door. City will stick by their long-serving captain in his bid to get himself fit, believing him to be one of the world's best centre-backs if he can stay healthy.

Raheem Sterling, who has struggled for consistency in his first season at City following his £49m move from Liverpool last summer, will also be given time to prove his worth under Guardiola, who is a huge amdirer of Kevin De Bruyne.

It is hard to accept Pellegrini's claim that City's decision to announce the managerial change has not had a detrimental effect on his players. But there had been signs of the team's decline ever since their blistering start to the season. Certainly their ability to fight back has diminished. Of the last 19 games they have trailed at half-time, they have gone on to lose 18, drawing the other.

City's board accept the ultra-competitive Premier League will come as something of a culture shock for Guardiola but are totally convinced he is the man to get them back on track and will deliver the sort of high-intensity attacking football they want.

They will give him greater autonomy than he has had at Bayern Munmich, where it is understood midfielder Toni Kroos was sold to Real Madrid against his wishes in 2014.

And City sources say he will not be overwhelmed by the politics that marred the end of his spell at Barcelona.

He will work closely with Begiristain, his team-mate in Barcelona's dream team that won the club's first European Cup in 1992.

City have huge hopes for their academy, which they hope will develop enough talent to ensure half of their first-team players are home-grown in the next five years, emulating Barca's famed La Masia academy which produced Lionel Messi, Iniesta and Xavi.

Guardiola can only dream of unearthing that calibre of talent but he will have the considerable financial resources of Sheikh Mansour to use in the meantime.